Cost of goods sold

Cost of goods sold is the direct cost of producing or delivering the goods and services that a company sold during the period (a quarter or a full year). It is the first and largest deduction from revenue on the income statement.

It includes raw materials, direct labour, and manufacturing overhead for a producer; the wholesale purchase price of goods for a retailer; hosting, support, and third-party software costs for a SaaS business; and the salaries of billable staff for a professional services firm. In every case the defining characteristic is that the cost is directly tied to what was sold, not to running the organisation.

Costs that do not meet that test: sales, marketing, executive salaries, office rent. These fall below gross profit in operating expenses.

The boundary between cost of goods sold and operating expenses is not always drawn the same way across companies, particularly for costs like customer support or quality assurance that some businesses classify as direct and others treat as overhead. This is why gross margin comparisons across companies in the same industry require care.

A declining gross margin is one of the earliest and most reliable warning signs in financial analysis, typically signalling rising input costs, deteriorating pricing power, an unfavourable shift in product mix, or a combination of all three.